At the end of November and in early December volatility has bounded back into financial markets. A couple of reasons have been cited for this, namely the introduction of the new COVID variant, Omicron, and recent comments by Federal Reserve Board Chairman Jay Powell. In those comments, he has suggested that the Federal Reserve may pare back its bond-buying program in hopes of slowing down inflation.
I believe that both of things contributed to the stock market’s pullback, although the bond market is suggesting that it has more to do with COVID than with Mr. Powell. What strikes me as odd about these reasons is that they are not especially new. Many observers have been suggesting for months now that inflation is running a bit hot, and there have been many calls for the Fed to start tapering its bond purchases. I think most of us who have shopped recently have noticed the higher prices that inflation brings. I also don’t think that if I had suggested a couple of months ago that there would be a new COVID variant that anyone would have been surprised. Yet before we understand anything about the new strain, the S&P 500 has pulled back 4% or so. I don’t know any more about Omicron than anyone else, I don’t think, but what I have heard doesn’t make me want to panic. Caution is wise, but not panic.
What I really think is happening is that the S&P 500 had run up so much, roughly 9% between the end of September to its recent peak (annualizing out at 54% or so), that stocks had grown tired, more or less, and any bad headline was likely to knock it back. Believe it or not, we are still about 5% above support levels. I’m not calling for it to fall by that much, but it would take that sort of pullback before I started to grow concerned about future stock prices.
As I wrote above, I don’t expect stock prices to fall by another 5%, although 10% pullbacks in stocks historically have occurred about once a year. I believe that most of the market’s recent action has been computer-trading algorithm related, and that the typical investor is not selling stocks and buying 10-year Treasury bonds yielding 1.5%. In fact, I’ve yet to have a client call to sell, although a few have called in nervously. Of course, computer selling still makes stocks go down in price, but I believe the selling will run out of steam soon.
I still favor stocks over bonds, and domestic stocks over foreign equities. Of course, each person has their own risk tolerance and portfolio goals, but within that risk framework, I suggest overweighting stocks. There is some evidence that small company stocks will continue to outperform and, while I favor large stocks, adding some small-cap exposure might make sense for a lot of investors.
We are in a seasonally strong time of year, historically. Corporate earnings reports have been great, and earnings growth looks solid for next year. Interestingly enough, since 1950 there have been 19 occurrences with a +20% return for the S&P 500. 16 of those occurrences (84%) have been followed by positive performance the following year, by an average of 11.5%. So even though the stock market has had a good year (the S&P 500 is up 21.6% in 2021), that does not mean that a bad one will follow. In fact, historically, it has meant the opposite.
I’ll be keeping an eye on what the Federal Reserve does with interest rate policy. If they start raising rates, I might start to get more cautious on stocks. But given that the Fed is basically doing the opposite of raising rates by buying bonds (which keeps rates low), I don’t think a rate hike is coming soon. Even if the Fed does begin to taper bond purchases even more, it still will be providing liquidity to financial markets.
Other than portfolio management, I am also making sure Required Minimum Distributions (RMD) from IRA accounts are done by the end of the year. If you haven’t taken yours, or if you aren’t sure, please make sure to call your advisor as soon as you can. The deadline is fast approaching, and if an IRA owner who must take an RMD (basically, if you turned 72 in or before 2020) waits until the very end of the year, it may not get processed correctly. The IRS levies a 50% penalty on RMD amounts that are not withdrawn, so please make sure to do it.
The same goes for charitable contributions from IRAs or gifts of stock. Those deadlines are almost here, so please make sure you complete those soon if that is your intention.
The deadline is also approaching for tax-loss selling. There aren’t many losses out there this year, but you may want to check with your advisor to see if there is a way to minimize capital gains. Mutual funds will be making distributions throughout December, and I expect that they will be pretty big this year.
The New York Stock Exchange will be closed on Christmas Eve, and many of our offices will be closed in observance. There is no closure for New Year’s Day this year, since it falls on a Saturday.
As always, these opinions are mine, and may or may not be the same as those of Raymond James. This is not a solicitation to invest, although we do invite you to review your portfolio with us to see if any changes should be made.
Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing involves risk including the possible loss of capital. Asset allocation and diversification do not guarantee a profit nor protect against loss.
The forgoing is not a recommendation to buy or sell any individual security or any combination of securities.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Individuals cannot invest directly in any index. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. Commodities and currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Scott Mitchell and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.